Markets
BHEL’s profit hinges on execution
Summary
In its earnings call, the management noted that the demand for coal-based thermal power plants gained traction after a gap of three years in FY23.Bharat Heavy Electricals Ltd’s (BHEL) financial results for the quarter ended March are not particularly bright, but the management’s upbeat commentary on its business prospects has sparked interest in the stock. The shares of the state-run power equipment maker are up by 4%since the results were announced.
In its earnings call, the management noted that the demand for coal-based thermal power plants gained traction after a gap of three years in FY23.
This comes on the back of increasing industrial activity, which has created demand for electricity. The company’s thermal order pipeline is healthy and it is of help that competition is low in the segment. “Coming to the thermal pipeline, we are looking at almost 3,700 MW where we are favourably placed," said the management. Furthermore, an additional 6,000 MW is under bidding stage. Beyond FY24, an order worth 9,000 MW is in the pipeline.
BHEL’s total order book as of FY23-end was ₹91,336 crore. This means order book-to-sales ratio is about four times, providing good revenue visibility. Coming to BHEL’s March quarter results: consolidated operating revenue rose by just 3% year-on-year, hinting at muted execution. Last quarter’s revenue was 20% lower than March 2019 quarter (pre-covid levels). While gross margin is up year-on-year and sequentially, it was still 1,200 basis points below pre-covid levels, said Kotak Institutional Equities analysts.
Its full-year margin performance is another damper. BHEL’s gross margin has fallen five times in a row. It was 30.2% in FY23 down from 44.2% in FY18.
Most analysts are not quite excited about BHEL’s prospects and have cut their earnings estimates post-results. “We cut our FY24E earnings per share by 80% due to lower margins in legacy orders and maintain our FY25E earnings per share of ₹5.5/share as we expect execution on new orders (high-margin projects with better payment terms) to gather pace," said ICICI Securities in a report on 28 May. Moreover, the thermal power projects are long gestation ones. Plus, out of the order backlog of close to ₹72,000 crore for power, about ₹17,000 crore worth of orders are slow-moving.
“BHEL continues to bid aggressively for incremental thermal orders. Order inflows remain benign, making it difficult to gauge the pace of margin recovery from hereon," said Kotak’s analysts. “Order inflow is a lesser problem as the pipeline of incremental ordering is healthy for the thermal, defense and transportation sectors. It is the difficulty of predicting profitability that is the constraint," they added.
To be sure, thermal order inflow would not be at the same pace as seen in the earlier years given the focus on sustainability. “Global push-back against thermal gives us conviction that any revival of thermal project tendering in India will have a limited shelf life," said analysts at Axis Capital in a report on 28 May. Axis has cut FY24 earnings per share estimates by about 5%.
As such, it is crucial for BHEL to diversify into other areas. The company targets to increase its revenue contribution from the industrial segment from almost 21% in FY23. It is banking on orders from sectors such as defence, railways, nuclear and hydro. This quarter, BHEL and Titagarh Wagons Ltd won Vande Bharat order worth ₹23,500 crore. But given that tender value was reduced 12%, extent of profitability remains to be seen.
BHEL’s shares are down by about 10% from their 52-week highs of ₹91.55 apiece in December. While the outlook of order inflows is healthy, execution remains the key factor that is to be tracked.
